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If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after briefly looking over the numbers, we don't think Kip McGrath Education Centres (ASX:KME) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
Return On Capital Employed (ROCE): What is it?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Kip McGrath Education Centres:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.11 = AU$2.5m ÷ (AU$35m - AU$12m) (Based on the trailing twelve months to December 2021).
So, Kip McGrath Education Centres has an ROCE of 11%. On its own, that's a standard return, however it's much better than the 6.7% generated by the Consumer Services industry.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Kip McGrath Education Centres' past further, check out this free graph of past earnings, revenue and cash flow.
The Trend Of ROCE
When we looked at the ROCE trend at Kip McGrath Education Centres, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 11% from 20% five years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 35%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 11%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.
The Bottom Line
In summary, despite lower returns in the short term, we're encouraged to see that Kip McGrath Education Centres is reinvesting for growth and has higher sales as a result. And long term investors must be optimistic going forward because the stock has returned a huge 231% to shareholders in the last five years. So should these growth trends continue, we'd be optimistic on the stock going forward.
Kip McGrath Education Centres does have some risks, we noticed 5 warning signs (and 2 which are potentially serious) we think you should know about.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.